Legacy Assets Proved Historic Shock to the System

It was a shock and it was unprecedented. The NCUA hammer brought down on the legacy assets held by the corporate system during 2010 caused it to reel as never before.

The ripple effect from the NCUA rulings on those assets are still causing economic pain for thousands of natural person credit unions from coast to coast while also forcing the massive restructure of the corporate network.

Despite the negative fallout from the five seized corporates-three of which were taken over Sept. 24-the silver lining from the legacy asset conundrum has been that only the seized corporates (WesCorp, U.S Central, Southwest Corp., Members United and Constitution Corp.) had their legacy assets packaged up into new securities and sold on Wall Street.

Nonetheless, toxic assets from the five seized corporates addresses more than 90% of all legacy assets and 98% of losses to the industry, sources noted.

Other corporates that own legacy assets, like Southeast Corp., SunCorp and others, will get to keep theirs and ride them out. This is important because the NCUA considers all investments not allowed under new rules to be legacy assets. So, as it turns out, not all are bad investments, with some expected to turn a decent profit in 2011.

For the smaller corporates that weren't seized, that was a big concern because they were depending on the income of those good performers to get through the next couple of years and transition into the new rules, according to analysts.

In short, corporates that didn't get seized on Sept. 24 breathed a huge sigh of relief as things turned out fairly good for them, noted corporate observers.

Under the new NCUA rules, corporates that own legacy assets but were not seized by the NCUA will be expected to remove them from their balance sheets but can hold them to maturity if they successfully prove that is the least costly resolution for members.

Also under the NCUA rules, legacy assets will be pooled and placed into a trust for securitization. The investments will be structured to match estimated incoming cash flow from the assets.

Although signs of what the NCUA had in store for legacy assets started appearing in May, it was not until the Sept. 24 seizures that it become clear that the NCUA was adhering to a "good bank, bad bank" plan.

In essence, NCUA decided to pool distressed investments from the five seized corporate credit unions and issue securities against the collateral.

Inactive "bad bank" corporate charters and the legacy assets attached to them were placed into a trust and transferred to the NCUA's Asset Management and Assistance Center in Austin, Texas, for management.

As the NCUA saw it, the trust structure allowed it to securitize the bonds without having to realize part of all of the unrealized losses, which would result in an immediate and severe write-down.

The NCUA has estimated credit losses on the underlying bonds will range from $14 billion to $16 billion and will serve as the investments' overcollateralization. The net difference between $50 billion in outstanding principal and estimated credit losses will determine the market value of the reissued bonds, approximately $35 billion.

The $50 billion price tag represents unpaid principal and interest outstanding on the investments, rather than original purchase price or current market value, Fazio said.

The investments were to be carefully structured so that incoming cash flow will service outgoing payments to investors, Fazio added. Approximately 70% of the securities are to have floating rates tied to Libor. The remaining 30% will have fixed rates.

Fazio said in the fall that the NCUA was not expecting to ever have to make a guarantee payment and that the NCUA consulted with the Federal Reserve Bank, U.S. Treasury and bonds experts to estimate future performance. Fazio said the agency remained very confident in its figures and if the bonds perform worse than estimated, credit unions will have to fund the shortfall.

During the year, Members United's investment portfolio came under a harsh spotlight since for a time it was experiencing credit losses.

In May the total fair value of assets was $9.5 billion. Cash and cash equivalents had increased over the prior year to represent 43% of total investments, plus overnight deposits at U.S. Central, for a $4.1 billion total. Fair value of marketable securities represented $3.5 billion of total assets, loans to members represented $700 million, term deposits at U.S. Central totaled $1.1 billion and accrued income and other assets totaled $100 million.

Members United owned 153 securities as of a year ago, with a total par value of $2.4 billion, that have been downgraded below a credit rating of BBB.